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Financial Accounting (INT)
Class Notes December 2009
The following notes are suitable for both the international and UK streams. There will some terminology differences between the two streams. These are summarised below:
International Statement of comprehensive income Statement of financial position Non-current assets Inventory Trade receivables Non-current liabilities Trade payables Irrecoverable debts
UK Profit and loss account Balance sheet Fixed assets Stock Debtors Long term liabilities Creditors Bad debts
Contents Paper background Session 1 Session 2 Session 3 Session 4 Session 5 Session 6 Session 7 Session 8 Session 9 Session 10 Session 11 Session 12 Session 13 Introduction to accounting Financial statements Double entry book keeping Non-current assets Inventory Irrecoverable Debts Control Accounts Bank Reconciliations Accruals and prepayments Limited Company accounts Statements of cash flow Incomplete records Partnerships
Aim The aim of this paper is to develop knowledge and understanding of the underlying principles and concepts relating to financial accounting and technical proficiency in the use of double-entry accounting techniques including the preparation of basic financial statements.
Main capabilities On completion of this paper, you should be able to: Explain the context and purpose of financial reporting Define the qualitative characteristics of financial information and the fundamental bases of accounting Demonstrate the use of double-entry and accounting systems Record transactions and events Prepare a trial balance (including identifying and correcting errors) Prepare basic financial statements for incorporated and unincorporated entities
The assessment The exam can be sat either written or computer based, both methods are 2 hours long. Written 40 x 2 mark questions 10 X 1 mark questions Computer based 40 x 2 mark questions Questions can be multiple choice, multiple response, matching or number entry 10 x 1 mark questions Multiple response (correctly identify two from three right answers) The pass mark is 50% Multiple choice A / B / C / D Multiple choice A / B or A / B / C
SESSION 1 INTRODUCTION TO ACCOUNTING Learning outcomes
• • • • •
Understand the purpose of accounting Identify the different types of businesses Indentify the users of accounts Explain the qualitative characteristics of financial statements Understand the underlying assumptions of financial statements
WHAT IS ACCOUNTING? Accounting is made up of two elements: I. II. Recording business transactions - Book keeping Presenting the information
WHAT IS A BUSINESS? A business is a commercial organisation which exists with a view to making a profit. There are different types of businesses which will fall into 3 categories: Sole Trader This is a business that is owned and operated by one person Partnership This type of business is owned by several individuals, some of which will actively be involved in the business Companies This type of business is owned by shareholders and is operated on their behalf by a nominated board of directors. Companies will be covered in greater detail in later sessions
Users of accounts
The users of accounts will depend on the type of accounts that are produced. There are two main types of accounts: • Management accounts • Financial accounts
These are produced as often as a business wants them (usually monthly). They are produced for internal use and will not, usually be seen by external people. Management accounts can be prepared using the company’s own internal policies.
These accounts are usually produced annually. They are based on historical information and are rarely used internally. Financial accounts are used by external users for several reasons:
this indicates an error in the initial entries.studyinteractive. In this case a suspense account is created until the errors can be detected. A business will use a trial balance as an INDICATION that all accounting entries have been recorded and all entries are correct. you should be able to: • • • Identify the layout of a Statement of Financial Position for a sole trader and a company Identify the layout of a Statement of Comprehensive income for a sole trader and a company Understand the principles and layout for a Statement of Changes in Equity Introduction There are four key financial statements: Statement of Financial Position This financial statement lists the assets and liabilities of a business at a point in time. www.org 7 . Statement of Changes in Equity This statement links the statements of comprehensive income and financial position. The starting point in the preparation of the financial statements is to produce a TRIAL BALANCE.SESSION 2 FINANCIAL STATEMENTS Learning outcomes After completing this chapter. If there is an imbalance. Statement of Cash Flow The statement of cash flow reports the cash generation and cash absorption for a “PERIOD OF TIME”. A trial balance MUST balance. It is a snapshot of the company’s position “AS AT A POINT IN TIME” Statement of Comprehensive Income This statement is a summary of the income and expenditure of the business for a “PERIOD OF TIME”. The trial balance is basically a list of ledger balances.
000 45.775 2.445 20. Statement of Financial Position as at 31 December 2007 Non – current assets Cost Buildings Fixtures and fittings Motor vehicles 150.260) (36.000 Current assets Inventory Trade receivables Prepayments Cash Total assets Opening capital Profit Drawings Non – current liabilities Loan Current liabilities Trade payables Accrued Loan interest Other accruals Total liabilities 12.000 33.800 3.465 51.490 32.000 15.352 28.900) 13.242 168.445 1.000 221.750 12.Proforma set of financial statements for a sole trader.250) (13.studyinteractive.000) (11.777 12.org 8 .510) NBV 138.787 (35.242 www.740 184.000 26.000 152.400 Dep’n (12.890 217.752 217.
439 (13.000 3.777) 233.666 8.009 132.662 114.444 10.134 4.332 119.449 Less: Expenses Discounts allowed Depreciation Gas and electricity Irrecoverable debts Loan interest Carriage outwards Water rates Advertising Other expenses NET PROFIT 3.122 7.000 118.org 9 .142 71.098 1.444 15.787 www.111 4.662 51.Statement of Comprehensive Income for the year ended 31 December 2007 Revenue Less: Cost of sales Opening inventory Purchases Carriage inwards Closing inventory GROSS PROFIT Discounts received Other income 12.000 123.studyinteractive.338 5.000 5.710 14.
Proforma set of financial statements for a limited company or Plc Statement of financial position as at 31 December 2007 Non – current assets Intangible assets Tangible assets Current assets Inventory Trade receivables Cash Total assets Equity and liabilities Share capital Retained earnings Revaluation reserve Non – current liabilities Interest bearing borrowings Current liabilities Trade payables Taxation Total liabilities 77.000 220.000 100.432 97.497 38.000 8 9 88.org 10 .286 7 358.789 587.999 199.497 5 128.287 587.455 13.000 187.000 10 100.studyinteractive.286 www.789 51.400 Note 6 7 200.
Statement of comprehensive income for the year ended 31 December 2007 Note Revenue (Sales) Cost of sales GROSS PROFIT Distribution costs Administration expenses PROFIT FROM OPERATIONS Finance costs PROFIT BEFORE TAX Income tax PROFIT FOR THE PERIOD 2 3 1 385.000) 220.S.000 112.500 37.000 100. www. 1 Presentation of Financial Statements.800 8. This structured format aids comparability and makes information more useful.000) (30.org 11 .studyinteractive. Notes detailing the balances in the financial statements are provided giving a detailed breakdown of the balance.800 53.000 188.000 59.000 38.000 Total 328.800 The format for company accounts is laid down in I.800 2.000 (30.497 Revaluation Reserve 40.000 197.697 59.000 (2.000 Retained Earnings 188.700 120.800 Statement Of Changes In Equity for the year ended 31 December 2007 (SOCIE) Share Capital Balance as at 1 Jan 2007 Profit for the period Surplus depreciation (not impt for F 3) Dividend paid Closing balance 100.497 38.697 59.A.000) 358.
A credit entry is a LIABILITY in the STATEMENT OF FINANCIAL POSITION or an INCOME in the STATEMENT OF COMPREHENSIVE INCOME T accounts In order to assist us with the preparation of the financial statements we use T accounts for simplicity. There are some basic rules that we MUST follow: 1.org 12 . Double entry bookkeeping Double entry bookkeeping is the fundamental concept underlying accountancy.SESSION 3 DOUBLE ENTRY BOOK KEEPING Learning outcomes When you have completed this chapter.studyinteractive. A debit entry is an ASSET in the STATEMENT OF FINANCIAL POSITION or an EXPENSE in the STATEMENT OF COMPREHENSIVE INCOME 3. All accounting transactions should be recorded using the double entry system. Every debit must have a credit 2. you should be able to: • • • Understand the principles of double entry bookkeeping Apply double entry bookkeeping to a list of transactions Prepare financial statements for a sole trader Introduction Bookkeeping is “the recording of monetary transactions” of a business. The principles of T accounts are: • • • Every debit entry has a credit entry Every T account will belong to the statement of financial position or the statement of comprehensive income The closing balance of a T account at the end of the period is entered into a trial balance www.
000 in to a business 1 April He purchases $5.000 on credit 10 April Purchased goods on credit for $7.org 13 . • • • • • • • • 1 April He invests $50.000 14 April He purchases a delivery van for $7.000 cash Required For the first two weeks of trading prepare: • • • • The T accounts for George (State if the account is Position or Income) The trial balance The Statement of Comprehensive Income The Statement of Financial Position www.studyinteractive. The following transactions take place in his first two weeks of trading.000 cash 5 April He issues a cheque to pay for the goods he received on credit 4 April Pays his rent for April of $450 by cheque 7 April He sells his remaining stock for $6.000 worth of goods on credit 2 April He sells half of the inventory for $6.EXAMPLE 1 George commences business on 1 April 2006.
000 in to the business She purchases $8.000 cash Pays her rent for January by cheque $150 Sells half her inventory for $10.org 14 .studyinteractive.000 on credit Purchases some office equipment for $3.000 worth of goods on credit She sells a quarter of the inventory for $4.EXAMPLE 2 Tina starts her business on 1 January 2007.000 cash Issues a cheque to pay for half of the goods she received on credit Pays her insurance for January by issuing a cheque for $75 She sells the remaining inventory for $12.000 cash Withdraws $100 for petty cash Purchases office supplies worth $30 from petty cash Required For the first month of trading prepare: • • • • The T accounts for Tina (state if the account is Position or Income) The trial balance The Statement of Comprehensive Income The Statement of Financial Position www. The following transactions take place in her first month of trading: • • • • • • • • • • • • 1 Jan 2 Jan 2 Jan 3 Jan 14 Jan 15 Jan 16 Jan 18 Jan 20 Jan 21 Jan 25 Jan 31 Jan She invests $65.000 on credit Purchases inventory at a cost of $10.
000 7.000 4 April 14 April Trade Payables Rent Delivery Van Carried Forward 56.000 Trade Payables Dr 5 April Cr 5.000 Carried Forward 12.org 15 .000 12.000 Purchases Purchases Sales www.000 Bought Forward 7.000 10 April 12.000 7.000 1 April 7.000 12.000 5 April 6.000 Bought Forward 12.000 43.ANSWER TO EXAMPLE 1 GEORGE Bank Account Dr 1 April 2 April Cr 5.000 Bank Carried Forward 5.000 Purchases Dr 1 April 10 April Cr Trade Payables Trade Payables 5.550 Capital Account Dr 1 April Bank Cr 50.000 Bought Forward 43.studyinteractive.000 450 7.000 Capital Sales 50.550 56.000 12.
000 12.000 7 April 12.000 Delivery Van Dr 14 April Cr Bank 7.org 16 .000 12.000 Cr Bank 450 Trade Receivables Dr 7 April Cr Sales 6.Dr Carried Forward 2 April 12.studyinteractive.000 6.000 Bought Forward Rent Dr 4 April Cash Trade Receivables Cr 6.000 www.
000 12.000 69.000 7.George Trial Balance Statement Bank Account Capital Account Purchases Trade Payables Sales Rent Trade Receivables Delivery Van Total FP FP CI FP CI CI FP FP 450 6.000 Dr 43.org 17 .000 7.studyinteractive.550 50.000 Cr www.000 12.000 69.
000 12.George Statement of Comprehensive Income 2 Week Period Ended 14 April 2007 Sales Cost of sales Opening inventory Purchases 0 12.000) 5.studyinteractive.000 Closing inventory (7.000 GROSS PROFIT Less expenses Rent NET PROFIT 450 6.000 12.org 18 .000 www.550 7.
000 43.550 TOTAL ASSETS Capital Profit 50.550 Non Current Liabilities Current Liabilities Trade Payables 7.550 56.000 6.George Statement of Financial Position as at 14 April 2007 Non Current Assets Delivery Van Current Assets Inventory Trade Receivables Bank Account 7.org 19 .550 56.000 www.550 7.studyinteractive.000 6.000 63.550 0 63.
000 10.000 c/f 18.000 75 3.000 b/f 18.000 Trade Payables Dr 3 Jan Cr 8.000 Capital Sales Sales 65.000 150 100 71.000 18.000 2 Jan 14.studyinteractive.000 Bank c/f 4.000 b/f 71.000 Purchases Dr 2 Jan 16 Jan Cr Trade Payables Trade Payables 8.000 10.675 79.000 Purchases Purchases www.000 b/f Sales 14.000 14 Jan 10.000 18.000 18.ANSWER TO EXAMPLE 2 TINA Bank Account Dr 1 Jan 2 Jan 21 Jan Cr 4.000 3 Jan 4.org 20 .000 16 Jan 18.675 Capital Account Dr 1 Jan Bank Cr 65.000 18 Jan 20 Jan 25 Jan Trade Payables Insurance Office Equipment Rent Petty Cash c/f 79.
000 26.000 Insurance Dr 14 Jan Cr Bank 75 Trade Receivables Dr 15 Jan Cr Sales 12.org 21 .000 12.000 21 Jan 26.000 26.000 Office Equipment Dr 18 Jan Cr Bank 3.studyinteractive.000 Rent Dr Cr www.000 10.000 b/f Bank Trade Receivables Bank c/f Cr 4.Dr 2 Jan 15 Jan 26.
org 22 .20 Jan Bank 150 Petty Cash Dr 25 Jan Cr Bank 100 31 Jan Office Supplies c/f 30 70 100 100 b/f 70 Office Supplies Dr 31 Jan Cr Petty Cash 30 www.studyinteractive.
675 65.studyinteractive.000 14.000 18.000 26.000 3.000 Cr www.Tina Trial Balance Statement Bank Account Capital Account Purchases Trade Payables Sales Insurance Trade Receivables Office Equipment Rent Petty Cash Office Supplies Totals FP FP CI FP CI CI FP FP CI FP CI 75 12.org 23 .000 105.000 150 70 30 105.000 Dr 71.
000 Closing inventory GROSS PROFIT Less expenses: Insurance Rent Office supplies 75 150 30 255 NET PROFIT 12.Tina Statement of Comprehensive Income For January 2007 Revenue Cost of sales Opening inventory Purchases 0 18.000 18.studyinteractive.000 www.745 (5.org 24 .000) 13.000 26.
000 www.745 Non Current Liabilities Current Liabilities Trade Payables 14.org 25 .000 91.675 70 88.745 3.000 12.000 12.745 TOTAL ASSETS Capital Profit 65.745 77.000 71.745 0 91.studyinteractive.Tina Statement of Financial Position as at 31 January 2007 Non Current Assets Office Equipment Current Assets Inventory Trade Receivables Bank Account Petty Cash 5.
Examples of tangible non-current assets would be: Land and buildings Plant and equipment Motor vehicles Computers Fixtures and fittings Intangible non-current assets These assets have no physical substance. ACCA F3 concentrates on tangible non-current assets.org 26 . you should be able to: • • • • • • • Define a non current asset Distinguish between tangible and intangible non-current assets Explain the differences between capital and revenue expenditure Understand the concepts of I. however a knowledge of intangible non current assets is needed. This would generally mean for more than one accounting period.SESSION 4 NON CURRENT ASSETS Learning outcomes When you have completed this chapter.A.studyinteractive. 16 Accounting for non-current assets Compile a non current asset register Calculate and account for depreciation Record the accounting entries for disposals of non-current assets Introduction A non-current asset is intended for “continued use” in a business. Tangible non-current assets These are assets that have physical substance. Non-currents assets can be either TANGIBLE or INTANGIBLE.S. An example of an intangible non-current asset would be: Goodwill Development www.
org 27 .S. a non current asset register is maintained. The key accounting standard relevant at this level is I.A. A non-current asset register is generally maintained in the finance department. A register would include the following information: • • • • • • • • • Item code Date of purchase Item description Cost Estimated useful life Residual value (if any) Depreciation method Location Disposal details www. In order to ensure management are aware exactly where each item is located and that they are adequately maintained and serviced. Companies can purchase specifically designed packages or a register can simply be maintained on an Excel spreadsheet.Non-current assets are normally of substantial value and their accounting can have a material impact on the financial statements. 16 Non-Current Assets Non-current asset register The majority of companies will own a number of non-current assets. As a result of this there are large numbers of accounting standards that help the preparers of financial statements to account for them.studyinteractive. and it is imperative that effective control is kept over them.
We need to classify expenditure incurred as either capital or revenue in order to ensure appropriate accounting entries are made.org 28 . If it is revenue expenditure it will be expensed through the statement of comprehensive income.A.S.studyinteractive. 16 are: • • • Insurance costs Repairs Maintenance EXAMPLE 1 Capital Purchase of a motor vehicle Purchase of a tax disc Fuel Insurance C D player Alloy wheels New tyre Early settlement discount Revenue Depreciation www. If it is capital expenditure it will be capitalised in the statement of financial position and then depreciated over the useful economic life of the asset.A. Capital expenditure is expenditure likely to increase the future earning capacity of the organisation whereas revenue expenditure is regarded as maintaining the organisation’s present earning capacity. Per I. 16 the following costs may be capitalised on acquisition of a non-current asset: • • • • • • • Initial cost Delivery costs Non-refundable import taxes Installation costs Any costs incurred in bringing the asset into intended use Initial training costs Subsequent expenditure that ENHANCES the performance of the asset Costs that are regarded as revenue expenditure and may not be capitalised per I.Capital and revenue expenditure One of the key areas of accounting for non-current assets is deciding whether expenditure incurred is CAPITAL or REVENUE expenditure.S.
Intangible non-current assets are amortised over their useful economic life (this is just another term for depreciation).org 29 . To calculate the depreciation charge the following formula is used: Depreciation per annum = Original cost – estimated residual value Estimated useful Life www. we are consistent with the ACCRUALS / MATCHING CONCEPT i. The main methods of calculating depreciation are: • • Straight line Reducing balance Straight line depreciation Depreciation is charged on a straight line basis over the life of the non-current asset. By applying depreciation charges. Depreciation policies Calculating depreciation in a given period are common questions in this paper.Depreciation is the charge to the statement of comprehensive income to reflect the consumption of an asset in a period.studyinteractive. with the exception of land. All tangible non-current assets should be depreciated on a systematic basis per I.A.S. 16. This is because land is seen to appreciate in value. applying the cost of using the asset to the statement of comprehensive income for the same period.e. Thus an equal amount is charged in every accounting period over the life of the asset.
EXAMPLE 3 Company B purchases a machine for $23. A fixed percentage is charged to the net book value on an annual basis.EXAMPLE 2 Company A purchased a non-current asset on 31st July for $150. Calculate the depreciation charges for the year ended 31st December on the basis: i.000.000. ii.org 30 . Motor vehicles tend to depreciate rapidly in the earlier years and require very little maintenance. EXAMPLE 4 Company C purchases a motor vehicle for $25. Calculate the depreciation for the first three years. The asset has an expected useful life of 5 years and a residual value of $20.000. the depreciation charge reduces accordingly. Once the depreciation charge has been calculated it should be entered into the accounts via a journal.000. The journal for depreciation is: Dr Cr Depreciation expense Accumulated Depreciation (Statement of comprehensive income) (Statement of financial position) www. A good example would be a brand new motor vehicle. A full year’s charge is made in the year of acquisition and none in the year of disposal. Hence.000 and will depreciate it at a rate of 25%.studyinteractive. as the book value of an asset reduces. What is the annual depreciation charge? Reducing balance This method of depreciation is generally used for assets which tend to lose more value in the initial years and require greater maintenance in the later years. The company’s policy is to time-apportion depreciation charges. They expect to use it for four years and then sell it for $3.
Required: Complete the necessary journals to account for the revaluation. The property has been valued by a qualified person at $150. The directors would like to encompass these figures in the financial statements. If a company chooses to revalue an asset they must revalue all assets in that category Revaluations must be regular Subsequent depreciation must be based on the revalued amounts Gains from revaluations are not taken to the statement of comprehensive income. EXAMPLE 5 Company X purchased a building for $45. iv.Revaluations When a non-current asset is purchased we record them at their initial cost. In order to overcome this issue I. if a company purchased a property 20 years ago and therefore subsequently charged depreciation for 20 years. and if so the following rules must be applied per the standard: i.studyinteractive. www. However.000 during the current financial year. This is covered by the PRUDENCE concept. over time these values may materially differ from their market value. and charges depreciation of 2% on a straight line basis. 16 permits companies to reflect the market value in the statement of financial position. as no gain as been realised.A.S. For example. iii.000 15 year ago. it would be safe to assume that the book value of the asset would be significantly different from today’s market value. ii.org 31 . This policy may be adopted.
EXAMPLE 6 Company C has a motor vehicle with a book value of $6.000 (proceeds – book value).000) and disposes of it for $8.org 32 .Disposal of a non-current asset When a business disposes of an asset it is unlikely that the sale proceeds will agree with the net book value.000 Dr Cr Accumulated depreciation $16. Therefore. Clear the depreciation from the accumulated depreciation account 3. The accounting entries will need to follow three steps 1.000.000 $8. a gain or loss will arise from the sale.studyinteractive.000 Dr Cr Bank Disposal Account $8. Clear the cost from the cost account 2. We can establish that there is a gain of $2. Enter the proceeds The entries are therefore: Dr Cr Disposal Account Motor vehicle cost account $22.000 (cost $22.000 Disposal Account $16.000 $22.000 ANSWERS TO EXAMPLE 1 www.
000 x 5 12 = 10.516 x - 25% 4.000 = 5.000 25.studyinteractive.000 x 25% 6.org 33 .000 25.Purchase of a motor vehicle Purchase of a tax disc Fuel Insurance C D player Alloy wheels New tyre Early settlement discount Capital √ Revenue √ √ √ √ √ √ √ ANSWER TO EXAMPLE 2 i 150.688 x 25% www.250 4.000 4 3.000 ANSWER TO EXAMPLE 4 Year 1 Year 2 Year 3 25.000 5 20.250 6.833 ANSWER TO EXAMPLE 3 23.250 = = = 6.688 3.000 = 26.000 Ii 26.
500 Accumulated depreciation post revaluation 150.studyinteractive.286 Building Cost Account 45.500 Dr Cr Depreciation Accumulated Depreciation 4.000 / 35 Years = 4.286 4.ANSWER TO EXAMPLE 5 Pre Revaluation Accumulated Depreciation 13.500 Cr Revaluation Reserve 118.500 Building Cost Account 150.500 Post Revaluation Accumulated Depreciation 4.000 Net Book Value 145.000 13.000 X 2% X 15 Years = 13.286 pa Journals Required Dr Dr Buildings Cost Accumulated Depreciation 105.org 34 .714 Accumulated depreciation pre revaluation 45.286 www.000 Net Book Value 31.
A.org 35 . – First In First Out The closing inventory consists of items purchased at the latest dates. I. A. Understand and apply the double entry for inventory Introduction Inventory is the product we purchase and sell in a business.) By applying the I. In times of rising prices. 2 Inventories Explain and apply the different methods of inventory valuation including F. Valuation of closing inventory We will cover three methods of valuing the closing inventory: F. www.I.S.S. Opening and closing inventory needs to be included in the statement of comprehensive income in order to calculate the cost of the goods sold with-in a given period. RULE: Closing inventory should be valued at the lower of cost and net realisable value (N. 2 rule we ensure our inventory is never overstated in the statement of financial position. hence the PRUDENCE concept.I.F.I.S.V. 2 is the accounting standard that gives us detailed guidance on how to value our closing inventory. In a business it is unlikely that all of the inventory will be sold at the end of an accounting period. and L.A.R. closing inventory will have a higher cost and therefore profit will be higher.. therefore there will be an adjustment needed in the financial statements for the value of the closing inventory. as we assume the items that were purchased first were the items sold first.C.O.V.O.F.O.studyinteractive. The statement of financial position will show the value of the inventory at the end of the accounting period (the closing inventory).SESSION 5 INVENTORY Learning Outcomes When you have completed this chapter you should be able to: • • • Explain the principles of I.O.A.F.
and as a result of this I. – Work in progress In some cases.Weighted average cost (AVCO) Under this method we assume: • • All units are issued at the current weighted average cost per unit A new average cost is calculated whenever more items are purchased L.F. In times of rising prices the closing inventory will have a lower value and therefore profit will be lower. Net realisable value Net realisable value is the amount we can get from selling inventory less any further costs to be incurred.P.S.O.I. Accounting Entries The double entry to account for closing stock is: Dr Cr Inventory Inventory Statement of financial position Statement of comprehensive income www.O. From a practical perspective it is unlikely last items purchased will be sold first. W.org 36 . where a company has modified it’s inventory it is necessary to take the cost of that modification into account when valuing closing inventory. as we assume the last item purchased is the first item to be sold. method of stock valuation.F.I. – Last In First Out The closing inventory consists of items purchased at the earliest date.A. 2 does not permit L.I.studyinteractive.
25 5.75 5.000 3.studyinteractive.735 Sales 7th 13th 17th 29nd 300 400 300 700 1.000 17.EXAMPLE 1 Navigator Office Supplies made the following purchases and sales in January: Purchases 3rd 12th 16th 22nd 31st 500 500 400 700 900 3.000 2.40 = = = = = 2.300 1.00 4.00 = = = = 3.900 3.org 37 .00 10.00 10.00 10.000 pens pens pens pens pens @ @ @ @ @ 4.000 Required Assuming there is no opening inventories prepare the statement of comprehensive income using the following: • • • LIFO FIFO AVCO www.60 4.700 pens pens pens pens @ @ @ @ 10.860 14.675 4.000 7.000 4.
00 700 5.00 Total 2000.860 $2.700 pens 1.00 700 5.00 1735.00 6595.00 1260.75 1425.00 F.00 300 4.40 4860.60 2300.00 3100.studyinteractive.25 3675.960 3.org 38 .00 300 4. 500 200 700 300 700 400 1100 400 1300 BALANCE Cost Total 2000.000 pens 1. IN Date 03/01 07/01 12/01 13/01 16/01 17/01 22/01 29/01 31/01 900 5.75 1900. 500 Cost 4.00 No.25 3675.00 No.00 500 4.00 3160.300 pens www.00 1200.60 1840.FO.00 5410.00 1735.00 800.O Total Purchases Total Sales Closing inventory Valuation 900 @ $5.I.I.ANSWER TO EXAMPLE 1 L.F. OUT Cost Total No.100 = $6.40 each 400 @ $5.00 400 4.25 each $4.00 400 4.
00 2007.00 1329.735 -6.F. OUT Cost Total No.775 9.00 22/01 29/01 700 5.00 1100 400 5520.I.00 Total 2000.00 No.org 39 .140 8.00 3100.00 No. 500 200 700 300 BALANCE Cost Total 2000.00 1200.860 0 14.960 7.00 800.00 300 3229 divided by 700 1384.40 4860.75 1900.60 2300. 500 Cost 4.000 AVCO 17.735 -6.F.868 9.735 -6.00 300 4.O.000 www.00 Therefore Income Statement is as follows: All $ Revenue Cost of sales Opening inventory Purchases Closing inventory 0 14.00 400 3100 divided by 700 1771. 17.25 3675.595 8.132 L.00 31/01 900 5.O. 17.AVCO IN Date 03/01 07/01 12/01 13/01 500 4.00 700 400 3229.I.studyinteractive.00 700 5520 divided by 1100 3513.00 1845.000 F.00 1300 6867.867 7.225 0 14.00 16/01 17/01 400 4.
800 Closing inventory includes the following damaged items: • • A table was purchased for $500. They can be sold for $20.000 $42. Required Calculate the cost of sales for 2007.studyinteractive. Four chairs costing $100 each were also damaged in the fire.548 www.130 101.800 Table Chairs 500 400 900 Cost of Sales Opening inventory Purchases Closing inventory 45.EXAMPLE 2 Radiance Kitchenware has the following items in their financial statements for the year ended 31st December 2007: Inventory @ 01/01/07 Purchases Inventory @ 31/12/07 $45.678 $98.org 40 .000 -42. Due to fire damage the maximum it can be sold for is $200 after a wax product costing $50 has been applied.130 42.678 98. ANSWER TO EXAMPLE 2 Stock Valuation Closing valuation Less Damaged inventory Add NRV Table (200 – 50) Chairs 150 80 230 42.
someone fails to pay we need to be able to account for this is our ledgers. gone bankrupt or disappeared. The double entry would be: Dr Cr Irrecoverable debts Trade receivables Statement of comprehensive income Statement of financial position EXAMPLE 1 www. and would therefore write the debt off. If this is the case we should not have this balance in our receivables. There are 2 types of debts that we need to consider: • • Irrecoverable debt (bad debt) Doubtful debt There is a clear distinction between irrecoverable and doubtful debts: Irrecoverable Debt This is a debt that you consider to be uncollectable.org 41 . It would not be prudent to hold a receivable in our statement of financial position if we were aware that they are unlikely to pay. Circumstances where this would occur are if the company has been fraudulent. Thus it is unlikely that we will receive the money due to us. The length of credit will vary between companies. but the most common length of credit is 30 days.studyinteractive. you should be able to: • • Explain the difference between a irrecoverable debt and a doubtful debt Compute the double entries required for irrecoverable debts and the provision for doubtful debts Introduction The majority of companies sell their product on credit. If however.SESSION 6 IRRECOVERABLE DEBTS AND PROVISION FOR DOUBTFUL DEBTS Learning Outcomes When you have completed this chapter.
org 42 . Dr Cr Bank Trade receivables We would then reverse the provision we had for this debt. If or when the company pays the debt the double entry would be the normal entry for a receipt i. George has heard that they have been closed down due to financial irregularities and that all the directors have disappeared. Bungle has left George’s sister and George is not sure if he will pay his debt which is due in 2 weeks time. Required How should George account for these items? Recovering debts written off If a debt that has been written off is later recovered. The entry required would be: Dr Cr Bank Irrecoverable debts Doubtful debt A doubtful debt is a debt that is owed to a business. As you can see the debt remains in the receivables ledger. we will need to adjust the ledgers to reflect this. as a result the company can still actively chase the debt. The double entry would be: Dr Cr Irrecoverable debts Provision for doubtful debts Statement of comprehensive income Statement of financial position This type of provision is called a specific allowance as we know exactly which debts the provision is for. but they are dubious about its collectability. The distinguishing factor is that this debt could be collected as it is doubtful not bad. Also included in the amount is $500 owed by Bungle who is George’s brother-in-law.000 that is owed by Zippy Traders. make a provision for this amount. We therefore.500.e.George has a small antiques business and at the end of the financial year ended 30th April 2007 has a receivables balance of $42.studyinteractive. Included in the year end balance is $4. General allowance www.
This would be calculated as a percentage of the receivables balance.000. At the year ended 31st December 2006 the company’s receivables are $135.000 – the company would like to maintain a 5% general allowance. EXAMPLE 2 For the year ended 31st December 2005 a company’s receivables balance was $150.studyinteractive.In order to apply the prudence concept we need to review our receivables at the end of the financial year and take a view of collectables. They had a general allowance of 5%. A large number of companies have a constant provision for receivables. Required What is the impact on the statement of comprehensive income and how will the receivables be presented in the statement of financial position? www.org 43 .
000 = $7.000 Bungle This debt is neither an irrecoverable or doubtful debt at this stage. We also have no reason to suspect that Bungle cannot afford to repay the debt.000 $4. This is because the debt is not yet due and we know where Bungle lives.ANSWER TO EXAMPLE 1 Zippy Traders This debt should be treated as an irrecoverable debt. ANSWER TO EXAMPLE 2 31ST December 2005 General provision – 5% x $150.500 www.studyinteractive.500 Double entry Dr Cr Irrecoverable debts Allowance for receivables 7.500 7.500 142. Therefore the entry needed would be: Dr Cr Irrecoverable debts Trade receivables $4.500 Extract from statement of financial position: Current assets Receivables General Allowance 150.org 44 .000 -7.
250 www.750 $7.31st December 2006 General Provision – 5% x $135.000 Provision bought forward Therefore overprovision Double entry Cr Dr Irrecoverable debts Allowance for receivables 750 750 = = = $6.500 $750 (7.500 – 6.org 45 .000 -6.750 128.750) Current assets Receivables General Allowance 135.studyinteractive.
This could be done daily. The number of transactions was limited. If an error had been made it would have been easy to detect. daily entries are normally made in a number of “Prime Entry” books and then a summary total is transferred to the nominal ledger periodically. www. and therefore the process was simple to follow. They are then transferred to the nominal (general) ledger and we then extract a trial balance in order to prepare our financial statements. in the real world of business the number of transactions is large.studyinteractive. you should be able to: • • • • • Understand the principles of control accounts Prepare the control accounts for trade receivables and trade payables Explain the function of a suspense account Prepare nominal ledger accounts Prepare journal entries Introduction In session 3 we prepared financial statements from T accounts. and to help us detect errors we use control accounts.org 46 . However. Therefore. weekly or even monthly.SESSION 7 CONTROL ACCOUNTS AND CORRECTION OF ERRORS Learning outcomes When you have completed this chapter. The following have a large volume of transactions on a daily basis and are used as prime entries: • • • • • • • Sales day book Purchase day book Sale returns day book Purchase returns day book Cash book Petty cash book Journal entries The transactions are recorded in the prime entry books.
This will also record any cash (settlement) discounts we allow or receive.studyinteractive. and any payments we make from the bank account. Petty cash book This records all the small sundry transactions occurring in a business on a day to day basis. They are also used to correct errors.org 47 . Cash book This book will record all the money that we will pay into the bank account. Purchase returns day book This book will record all the credit purchases that we return to suppliers. this will be recorded in the sales returns day book. Purchase day book This book of prime entry records all purchases we make on credit. Sales should be recorded net of trade discount but before cash (settlement) discount. Journal entries These are used for ad hoc entries that do not fall into any of the above categories.Sales day book This book records all the sales we make on credit. both temporary and permanent. www. Sale returns day book If a credit customer returns goods.
EXAMPLE 1 L & M had the following transactions during the first week in December 2007.studyinteractive. again with a 9.82 1169.12 1058.00 995.23 139.12 139.12 3277.00 900.06 TOTAL 1173.05 2624. 1st December 2007 • • • Purchased goods on credit from A Ltd for $595 receiving a trade discount of 9. 999241 867544 999242 A Limited K P Limited A Limited SUPPLIER NET 538.93 TOTAL 632.5% 94.5% SOLUTION SALES DAY BOOK DATE 01/12 03/12 05/12 INV NO.12 934.00 SALES TAX @17.12 488. 100555 100556 100557 J K Limited A Jones A Jones CUSTOMER NET 999.70 934.5% 174.82 174.47 2233.58 390.06 PURCHASE DAY BOOK DATE 01/12 01/12 05/12 INV NO.94 SALES TAX @17.5% trade discount NB Sales tax is 17.org 48 .00 2789.47 795.87 PURCHASE RETURNS DAY BOOK www.5% Purchased goods on credit for $795 from KP Ltd Sold goods on credit to JK Ltd for $999 3rd December • • Returned KP Ltd goods as they were defective Sold goods on credit to A Jones for $995 5th December • • Sold goods on credit to A Jones for $795 Purchased goods on credit from A Ltd for $995.12 157.00 795.
12 934.studyinteractive.DATE 03/12 INV NO.org 49 .12 795.12 www. 867544 K P Limited SUPPLIER VALUE 795.12 TOTAL 934.00 SALES TAX 139.00 139.
200 Required Calculate total cash received from customers in January Solution RECEIVABLES CONTROL ACCOUNT Dr All Jan Opening balance Sales day book Refunds 22.studyinteractive.650 23.EXAMPLE 2 The following are the balances on Explorers’ ledger accounts in the month of January Opening receivables balance Sales day book Cash sales Sale returns day book Refunds to customers Discounts allowed Irrecoverable debts Increase in provision Purchase ledger contra 22.555 3.475 Feb Opening balance 18.200 18.950 5.455 1.786 4.325 Cr All Jan Returns book Discounts allowed Irrecoverable debts Contra Closing balance Receipts (bal fig) 5.650 77.555 6.325 6.500 88.650 www.650 3.455 500 1.475 114.500 88.829 114.org 50 .786 4.
500 1.950 2.400 900 14.400 900 Required Calculate the closing balance for the payables account at the end of March.999 3.300 37.784 April Opening balance 57.034 Cr All March Opening balance Purchase day book 12.studyinteractive. Solution PAYABLES CONTROL ACCOUNT Dr All March Returns outwards Payments Discounts received Contra Closing bal (bal fig) 3.785 44.034 Reconciling the control accounts www.org 51 .950 37.784 14.EXAMPLE 3 The following are the balances on a company’s ledger accounts in the month of March: Opening payables balance Purchase day book Returns outwards daybook Returns inwards day book Cheques paid to suppliers Discounts received Sales ledger contras 12.785 44.500 1.999 57.
Solution Until a full knowledge of double entry is known. 1 2 3 4 5 Location of Error Control Account Control Account Control Account Control Account Control Account Amend Control Account Control Account Control Account Control Account Control Account PAYABLES CONTROL ACCOUNT Dr All Dec Cr All Dec www. If there is an imbalance then it must be investigated.550. The main discrepancies are due to: • • • • • Casting error in the day books Posting error A one sided contra An entry that has been made in the individual account but not in the control accounts An entry being omitted from the control account EXAMPLE 4 At the financial year end 31 December 2007 Explorer Rain Wear had a balance on the payables control account of $22. The management accountant found the following discrepancies: 1.studyinteractive. the control account should balance.000 Goods returned of $1. The balance on their purchase ledgers was $20. 2.org 52 . An invoice of $1.650.Normally at the end of each month we check to ensure our control accounts reconcile to the individual balances on our ledger accounts. In this case: Error No.200 had been omitted from the control account The purchase day book total was overstated by $1. 4. We do this by: Checking our list of individual balances tie into the control account balance. 5.590 had not been recorded in the control account Discounts received of $10 had not been posted Contra entries of $500 need to be recorded in the control account After these adjustments are made. 3. the easiest way to tackle this question is to identify where the error has occurred and amend accordingly.
000 4.500 263.750 20.400 Bad debt provision is to be maintained @ 1.550 1.500 3.000 11.000 2.590 10 500 20.000 300.org 53 .580 17.650 Balancer per list 20.studyinteractive.750 Jan Opening balance 23.650 Original balance Error 1 22.200 23.500 Balance at 1 July 2005: Payables Receivables Provision for doubtful debts 53.000 22.000 12.Error 2 Error 3 Error 4 Error 5 Amended balance 1.650 EXAMPLE 5 Hippo Manufacturing had the following balances on their payables / receivables for the financial year ended 30 June 2006.500 17.5% of credit sales Required: Compute the receivables and payables control account and extract the closing balances for the financial year end.000 1. Credit sales Cash sales Credit purchases Cash purchases Returns inwards Returns outwards Discounts allowed Discounts received Irrecoverable debts Payments made to payables Cash received from receivables Contra’s 450.500 51. SOLUTION www.100 438.000 14.
900 353.500 Opening balance Credit purchases Cr 53.000 www.500 353.500 46.org 54 . Again until you are comfortable with debits and credits it is easier to write exactly where things will go before attempting to balance the accounts. It is designed to ensure you know exactly what should go into control accounts and also your knowledge of double entry. In this case: Receivables / Payables Credit sales Cash sales Credit purchases Cash purchases Returns inwards Returns outwards Discounts allowed Discounts received Irrecoverable debts Payments made Cash Received Contra Receivables Neither Payables Neither Receivables Payables Receivables Payables Receivables Payables Receivables Receivables / Payables Debit / Credit Debit n/a Credit n/a Credit Debit Credit Debit Credit Debit Credit Credit / Debit PAYABLES CONTROL ACCOUNT Dr Returns outwards Discounts received Payments Contra Closing bal (bal fig) 14.000 12.500 300.100 17.studyinteractive.000 263.This is a common CBA question.
580 17. If there is an imbalance a SUSPENSE ACCOUNT will be created.studyinteractive. This is extremely rare.RECEIVABLES CONTROL ACCOUNT Dr Opening balance Credit sales 51. The following are the main purposes of a trial balance: • • • Account balances are reviewed to check for obscurities Reconcile all control account balances with the individual ledgers Ensure debits equal the credits.920 501.500 Correction of errors At the end of an accounting period we extract a trial balance. Errors that will cause a difference in the trial balance are: • • • • Transposition error – Entering figures the wrong way round Single entries – Only one side of the transaction has been posted Both entries entered on the same side of the ledger account Casting error – An account has been incorrectly added Although extracting a trial balance proves the above. and use this as a basis for preparing the financial statements.500 14. Errors of commission – Entering an amount in the wrong account.500 438.000 Returns inwards Discounts allowed Irrecoverable debts Cash received Contra Closing bal (bal fig) Cr 17. Errors of omission – A transaction has been missed out.000 2.000 11. but in the correct financial statement. there are certain errors that a trial balance will not identify.org 55 . These are: • • • • Error of principle – An entry has been entered in the wrong financial statement. Compensating errors – Where two or more errors cancel each other.500 450. Therefore.500 501. a suspense account may have a debit or credit balance. Journals www.
000 on credit.000 7.Journals are used for several reasons: • • • • Post unique. Inventory purchased for $1.000.studyinteractive. A sales day book has been under cast by $1. 2.000 1.org 56 .000 has been posted to stationery 3. one off transactions Transfer items between accounts Adjust balances that are incorrect Correct items that have been incorrectly posted Journals should have a unique number and should be clearly labelled. but has not been recorded.000 Capital purchased 7.000 Incorrectly coded 1.000 Example 7 Peter has the following balances on its trial balance at the end of the financial year: www. Solution Account Name Sales Revenue Trade Receivables Stationery Purchases Non-current asset Other payables Description SDB under cast 1.000 Debit Credit 1. Example 6 Correct the following errors using journals: 1. A non-current asset has been purchased for $7.
after these errors have been corrected the balance on the suspense account should be removed.742 4. Solution Account Name Suspense Stationery Discounts allowed Suspense Suspense Other income Description Incorrect total posted Debit 340 340 Posting to incorrect side 2.742 3.742 Credit Suspense Account Journal 1 Journal 3 340 3. 1.620 4.Debit Credit $213.390 A suspense account has been created for the difference. 3.082 Opening Balance Journal 2 1.462 2.org 57 .studyinteractive.310 have been recorded as a credit. Other income of $3. Discounts allowed of $1.742 has only been recorded in the cash book.082 www. The following errors have been identified by the accountant. 2.852 $212. A payment for stationery for $440 was debited to stationery as $780. Required Correct the entries and clear the suspense account.620 2.620 One sided entry 3.
this can be done on a weekly or monthly basis. it is an asset from the bank’s point of view.SESSION 8 BANK RECONCILIATIONS Learning Outcomes When you have completed this chapter. Preparing a bank reconciliation has many advantages.studyinteractive. and it is important that the balance in the ledger reconciles to the balance on the actual bank statement. the bank has a creditor. Reconciling Items www. and in some larger companies even daily. if a bank statement shows a credit balance. Dependant on the size of the company. Therefore. If the bank statement shows a debit balance this indicates the business is overdrawn.org 58 . you should be able to: • • Prepare cash and bank accounts Prepare a bank reconciliation Introduction Within the ledger account is a bank account ledger. They include: • • • • Provides a check on accuracy of recordings in the cash book Highlights any errors Assists in the day to day cash management Any differences can be identified quickly Debits and Credits On a bank statement the balances will be from the perspective of the bank not that of the business. We call this exercise a bank reconciliation. i. In other words the bank owes the business money and is therefore in a positive position.e.
e.455 (1.org 59 .205 Preparing a bank reconciliation 1. but they will not appear on the bank statement until they are presented to the bank. www. standing orders. UNLESS OTHERWISE TOLD. These are called unpresented cheques. ASSUME FIGURES ON THE BANK STATEMENT ARE CORRECT.950) 1. This can be due to the following reasons: • Cheques issued by the company are immediately entered into the cash book. There may be items in the bank statement that have not been processed through the cash book e. Put in items that are in the cash book that have yet to be presented to the bank as a reconciling item.g. items on the bank statement that have not been processed through the ledger 3.700 65. dishonoured cheques and bank charges. BACS transfer.It is extremely unlikely that the balance on the ledger account and the balance on the bank statement will agree. Receipts by the business are immediately entered in the cash book and then banked. Compare the cash book and bank statement and tick matching items 2.studyinteractive. Post corrections to the cash book i. • • Proforma bank reconciliation Balance per bank statement Less : Unpresented cheques Add: Outstanding lodgements Balance per cash book 65. This can take a number of days to clear. direct debits.
500 350 1.300 17.800 19.100 3.200 1.650 1.050 13.800 16.500 14.050 15.550 16.100 18.950 20.050 19.200 750 750 750 250 3.500 3. 1439 Direct Debit – Direct Line 1441 BACS (Bank Automated Clearance System) Transfer 1442 29 Bank Charges Payment Receipt Balance 14.450 23.S.studyinteractive.095 Bank Statement Date 01/04/07 04/04/07 05/04/07 08/04/07 10/04/07 11/04/07 12/04/07 14/04/07 17/04/07 17/04/07 18/04/07 20/04/07 24/04/07 Details Opening balance 1437 1438 27 28 Standing Order – P.000 01/04/07 01/04/07 01/04/07 01/04/07 12/04/07 12/04/07 27/04/07 27/04/07 27/04/07 30/04/07 1437 1438 1439 1440 1441 1442 1443 1444 1445 c/d 450 600 750 150 250 350 395 165 245 20.100 500 www.300 18.Example 1 Cash Book 01/04/07 03/04/07 05/04/07 12/04/07 29/04/07 b/d 27 28 29 30 14.650 1.095 23.550 450 600 3.L.450 17.450 30/04/07 b/d 20.org 60 .
095 11/04/07 3.org 61 .595 Standing Order Direct Debit Bank Charges c/d 750 750 500 21.studyinteractive.550 (955) 3.000 21.595 Bank Reconciliation Balance per bank statement Less: unpresented cheques 1440 1443 1444 1445 30 150 395 165 245 19.595 30/04/07 b/d 21.595 23.595 Add: Outstanding lodgements www.500 14/04/07 24/04/07 30/04/07 23.Solution Cash Book 30/04/07 17/04/07 b/d BACS 20.
org 62 .390. 7. He has entered cheque payment number 100600 into the cash book as $1. 6. 2.860. 8. A cheque receipt for $1. 4. Required: Correct the cash book with the above and prepare a bank reconciliation. He has discovered cheque number 100678 has been entered into the cash book twice for $459.680. when the correct amount is $1. There are outstanding lodgements of $8.450 has been dishonoured by the bank. A BACS transfer of $6.550.Example 2 The assistant accountant of Rainbow is trying to prepare a bank reconciliation as at 30th November 2007. 5.196 has been received by the bank and not been accounted for in the cash book. There are unpresented cheques totalling $5. The cash book has a credit balance of $2.840. Bank charges of $1.studyinteractive. www.400 have been charged by the bank.400 and the bank statement at that date has an overdrawn balance of $1. As his manager he has asked you for help with the following items: 1. A direct debit of $225 has been taken from the account and not been entered into the cash book 3.
450 1.org 63 .400 225 1.000 6.840) 8.196 30/11/07 30/11/07 30/11/07 30/11/07 30/11/07 6.Solution: Cash Book 30/11/07 30/11/07 Chq 100678 (1) BACS 459 30/11/07 6.000 b/d Direct Debit (2) Dishonoured Cheque (5) Bank Charges (6) Chq 100600 (8) c/d 2.000 www.655 Bank Reconciliation Balance per bank statement Less : Unpresented cheques (3) Add: Outstanding lodgements (4) (1.400 180 1.655 30/11/07 b/d 1.studyinteractive.550) (5.390 1.
The adjustment is calculated using the most up to date information available. Example 1 .org 64 .SESSION 9 ACCRUALS AND PREPAYMENTS Learning Outcomes When you have completed this chapter. not as money is received or paid. you should be able to: • • Explain why adjustments are necessary when preparing financial statements Compute the adjustments needed Introduction The matching concepts states that income and expenses incurred in the period should be accounted for in that period. it is often necessary to adjust the financial statements. In the year ended 31st December 2007 the following bills were received and paid on the dates indicated. regardless of when invoices are raised or received. In the example above this will be the 31/10/07 bill.Accruals A sole trader receives his business gas bill quarterly in arrears. The fundamental rule is that income and expenditure are recognised as they are earned or incurred. Therefore the adjustment needed would be 2/3 x $300. • • • 30/04/07 31/07/07 31/10/07 $300 $310 $300 When preparing the accounts for the year end the accountant must adjust the Gas ledger account to reflect that not all charges have been recorded.studyinteractive. Accruals and prepayments will be the estimate of the adjustment needed. The entry needed would be: Dr Cr Gas account Accruals $200 $200 www. In order to ensure income and expenditure is recorded in the correct period. In this case charges for November and December need to be included.
110 01/01/08 Accrual b/d Inc Statement 1.The ledger account would therefore look like this: Gas Account 30/04/07 31/07/07 31/10/07 31/12/07 Cash Cash Cash Accrual 300 310 300 200 31/12/07 1.110 1. 2.org 65 . 07) www.110 200 It is important to remember to carry forward any accrual or prepayment to the next accounting period. (Assumption: business began on 1.studyinteractive.
800 01/01/08 Prepayment b/d 1.050 750 1.850 01/01/09 Prepayment b/d 1.800 Assuming the insurance charge remains the same for the year ended 31st July 2009.050 Prepayment (7/12) Inc Statement 1.800 31/12/07 31/12/07 1. Her year end is 31st December each year. and pays her business insurance for the year to 31st July 2008 totalling $1.org 66 .Prepayments Julie starts her business on 1st August 2007.800 31/12/08 31/12/08 2.050 750 1.800 01/01/08 01/08/08 Prepayment b/d Cash 1.800 Prepayment (7/12 Inc Statement 1.800 2.050 Prepayment (7/12) Inc Statement 1.studyinteractive. the ledger account would look like this: Insurance Account 01/08/07 Cash 1.050 1.800.050 1.850 www.800 31/12/07 31/12/07 1. What charges for insurance would be stated in the income statement for the period ended 31st December 2007? Insurance Account 01/08/07 Cash 1.Example 2 .
studyinteractive. if any involvement in the day to day running of the business and employ directors to run it on their behalf.org 67 .SESSION 10 LIMITED COMPANY ACCOUNTS Learning outcomes When you have completed this chapter. The shareholders have very little. Limited company financial statements have very strict requirements which must be followed by all companies. The owners of limited companies are referred to as shareholders and are often different from the people that run the company. These are governed by: • • Companies Act 2006 (or local country legislation) The International Accounting Standards Board www. you should be able to: • • • Prepare a statement of comprehensive income Prepare a statement of changes in equity Prepare a statement of financial position Introduction Many businesses are constituted in the form of limited companies.
studyinteractive. must be the format we adopt in our studies.497 5 128.000 220.000 100.789 51.789 587.000 8 9 88.org 68 .000 187.S.497 38.400 Note 6 7 200.286 www.000 10 100. however a copy is given below for reference: Proforma set of financial statements for a limited company or Plc Statement of financial position as at 31 December 2007 Non – current assets Intangible assets Tangible assets Current assets Inventory Trade receivables Cash Total assets Equity and liabilities Share capital Retained earnings Revaluation reserve Non – current liabilities Interest bearing borrowings Current liabilities Trade payables Taxation Total liabilities 77.999 199. The proforma financial statements for limited companies were given in session 2.455 13.287 587.The format to be adhered to per I.286 7 358.432 97.A.
org 69 .000) 358.800 2.697 59.000 59.000 188.studyinteractive.000 Retained Earnings 188.497 Revaluation Reserve 40.000 100.800 53.497 38.000 (30.800 Statement Of changes in equity for the year ended 31 December 2007 Share Capital Balance as at 1 Jan 2007 Profit for the period Excess depreciation Dividend paid Closing balance 100. A full set of statutory accounts will include: 1. Statement of comprehensive income www.Statement of comprehensive income for the year ended 31 December 2007 Note Revenue Cost of sales GROSS PROFIT Distribution costs Administration expenses PROFIT FROM OPERATIONS Finance costs PROFIT BEFORE TAX Income tax PROFIT FOR THE PERIOD 2 3 1 385.000) (30.000 (2.500 37.000 197.000 112.000 38.697 59.000) 220.000 Total 328.800 A limited company must file their statutory accounts with companies’ house.800 8.700 120.
Profits of a company are distributed by way of dividend payments. The name limited company comes from the fact that the shareholders have limited liability.studyinteractive.00 and the directors decide to pay a dividend of 75c per share. Ordinary share holders will receive a dividend if the directors decide to pay one. The nominal value (par value) is $1. Example 1 Freedom Limited has 100. Preference share holders will receive their dividend every year providing the company has distributable profit.2.75) in dividends Preference shares This type of share is known as a non-equity share. These payments are at the directors’ discretion.org 70 . Therefore. a company can sue individuals and can also be sued. This means that a company is deemed to be a person in its own right.000 (100. in other words their liability is restricted to the amount they have paid for their shares. If this is the case the company would pay $75.000 x 0.000 ordinary shares in issue. Cash flow statement These statements are supported by notes explaining the balances in the financial statements. One of the key differences between a company and a sole trader is that a company is classed as a separate legal entity. and gets a fixed return on the value of the share. www. Statement of financial position 4. Statement of changes in equity 3.
Example 2 The following information relates to Voyager Limited Year ended 31st December 2007 Share capital (25c shares) 6% Preference shares $ 100.000 The directors propose an ordinary dividend of 75c per share.75 Preference shares 50.25 = 400.000 50.000 300. Solution Ordinary shares 100.000 www.000 303. Required: Calculate the dividend payable.000 x 6% Total dividends paid 3.000 / 0.000 x 0.studyinteractive.org 71 .000 shares in issue 400.
000 x $1. This would be reflected in the share price.85) 50.000 shares for cash injection purposes.00) Share premium Retained earnings Revaluation reserve 250.00) Retained earnings Revaluation reserve 200.500 The Capital and reserves would now be: Share capital ($1.000 233.85) Bank (50.org 72 .456 125.000 www.85 and the directors wish to issue a further 50.500 233.456 125.00) Share Premium (50.000 x $2.000 142. Example 3 The following relates to Radiance Limited Capital and reserves Share capital ($1. As the company has established itself.000 Say the market value price per share is $3. it is unlikely they will issue them at a nominal/par value.Share premium If a company issues shares after the initial incorporation.studyinteractive. the net worth of the company would increase. The double entry would be: Cr Cr Dr Share Capital (50.500 192.000 x $3.000 142.
The accounting entry for this would be: Cr Dr Share capital Share premium Dividends As we have seen previously in this chapter.studyinteractive. Final dividends are paid after the year end. the company must have reserves that are distributable i.000 An interim dividend of 8c per share was paid during the year and the directors would like to propose a final dividend of 9c per share. Required: Calculate the total dividend payable for the year ended 31st May 2007. The key use of the reserve would be to finance a bonus issue of shares. Example 4 Share capital (50c) 10% Preference shares 200. once the financial statements have been completed. www.e. This is when the directors distribute free shares to existing shareholders. This means that the account cannot be used to pay out dividends.Capital reserve The share premium account is classed as a Capital reserve.000 25. An interim dividend can also be paid mid way through the year. The use of capital reserves is very limited. In order that a dividend can be paid. dividend payments are used to distribute profit to shareholders.org 73 . they cannot be paid out of any reserve that is not realised (Revaluation reserve). and the directors have decided the dividend amount.
000 2.500 32.50 = 400.Solution Ordinary shares $200.000 x 8c) Final dividend (400.org 74 . and is paid in the following year.studyinteractive. The tax charge is normally estimated at the end of the financial year and charged to the statement of comprehensive income.000 shares in issue Interim dividend (400.000 Taxation All companies have to pay tax on the taxable profits.000 x 9c) Preference shares 10% x $25.500 70.000 36.000 /$ 0. The accounting entry for taxation would be: Dr Cr Taxation Taxation liability Comprehensive income Financial position www.
000 6.000 49.000 422.945 73. A final dividend of 15c per share has been proposed before the year end.000 1. www. Depreciation on plant and machinery is to be charged at 10% reducing balance 3.000 69.987 5. Closing inventory was valued at $28.958 150.000 32.987 5.000 50.000 234.666 100.598 896.000 48.666 365. statement of changes in equity and the statement of financial position for Jewel Limited for the year ended 31st March 2007. Required Prepare the statement of comprehensive income.000 45.990 4.org 75 . A provision of 5% of receivables is to be maintained 5.00) Retained earnings at 01/04/06 Debenture 10% Inventory at 01/04/06 Trade receivables Receivables provision Trade payables Cash Building cost account Plant and machinery at net book value Debenture interest Administrative expenses Distribution expenses Profit on disposals Purchases Revenue Cr 100.Example 5 The trial balance of Jewel Limited as at 31st March 2007 was as follows: Dr Share capital (50c) 6% Preference shares ($1.598 Notes 1. Depreciation on building is to be charged at 2% 2. Tax charge is estimated at $25.000 896.987 39.studyinteractive.
688 Cr 3.5 x 15c) 30.987 x 5%) 2.299 28. Dr Cr Depreciation charge (150.Solution Journals Dr 1.000 30.org 76 .000 3.987 x 10%) Accumulated depreciation – P & M Closing inventory (comp income) Closing inventory (financial position) Receivables provision account Administration expenses Taxation Taxation liability Pref Dividends Proposed Div (prefs) Dividends in SOCIE (100. Dr Cr Dr Cr Dr Cr 8.000) Debenture interest accrual 5. Working 1 Receivables Provision Account 01/04/06 31/03/07 Admin expenses (written back to I/S) c/d (45.000 – 5.000 Proposed dividends Debenture interest (10.000 25.987 3.000 Work 1 42.000 25.990 3.Buildings 3.299 5.000 3.000 2. 6.000 3. 4.000 / 0.987 b/d 5. Dr Cr Dr Cr Dr Cr 5.000 5.990 28.000 x 2%) Accumulated depreciation .299 42.688 31/03/07 www.987 5.studyinteractive. Dr Cr Depreciation charge (422. 7.688 3.
000) 119.713 (10.org 77 .000 + 69666 – 28990) GROSS PROFIT Distribution costs Administration expenses (48.299 – 3688 + 1000) (88.000) 144.Jewel Limited Statement of Comprehensive Income Year ended 31st March 2007 Revenue Cost of sales (32.713 365.324 (49.000 (72.676) 292.611) PROFIT FROM OPERATIONS Finance costs PROFIT BEFORE TAX Income tax PROFIT FOR THE PERIOD 154.000) www.000 + 3000 + 42.713 (25.studyinteractive.
000 Pref Div) 100.379 471.299) 527.636 674.000 25.987 – 3.000 321.688 Current assets Inventory Trade receivables (45.324 100.987 – 2.000 – 42.324 www.000 50.688 73.studyinteractive.958 146.379 Non – current liabilities Debenture Current liabilities Trade payables Debenture accrual Proposed dividend Taxation 39.000 102.000 28.org 78 .000 33.299) Cash Total assets Equity and liabilities Ordinary share capital Preference share capital Retained earnings (234.000 – 3.666 + 119.945 5.990 43.000 + 422.Jewel Limited Statement of financial position As at 31st March 2007 Non – current assets Tangible assets (150.945 Total liabilities 674.713 – 30.
000) 50.org 79 .713 (30.000) Total 384.000) (3.666 119.000 100.000) (3.000 Preference Shares 50.379 471.666 119.000 Revaluation Reserve Retained Earnings 234.713 (30.Ordinary Shares Balance @ 01/04/06 Profit for the year Dividends: ord pref Shares issued Revaluation Balance @ 31/03/07 100.000 321.studyinteractive.379 www.
you should be able to: • • • • Explain the purpose of producing a cash flow statement Discuss the advantages of a cash flow statement Explain the principles of I.org 80 . especially in the short term. It highlights the key areas where a business has generated and spent physical cash.studyinteractive. Advantages • • • • • Cash flow balances are a matter of fact and are not distorted by accounting policies Cash flow balances are objective. If a business has limited cash funds available it will struggle to survive in the short term. but cash is equally vital for the success of a business.SESSION 11 STATEMENTS OF CASH FLOW Learning outcomes When you have completed this chapter. unlike profit which is subjective Users of financial statements can establish exactly the cash generation of a business Users can identify exactly how this cash has been utilised Users can assess the liquidity of a business and assess its ability to repay debts as they fall due Loans repaid and received are clearly listed in the cash flow statement Users can assess management attitude to capital expenditure Interest payments are highlighted in the cash flow • • • www. Good cash management ensures a business has sufficient cash to run its day to day operations. Prior to this session we have focused on profit.S. 7 Produce a cash flow statement Introduction The cash flow statement is a primary financial statement and provides fundamental information to the user of accounts.A.
Students should familiarise the layout of a cash flow as questions in the exam will test this area. 7 lays down the requirements of a cash flow statement.A.studyinteractive. highly liquid investments (will be stated as current assets in Statement of Financial Position) I.S. 7 has three main headings.org 81 . Cash equivalents Short term.S.I. The three main headings are: • • • Cash flows from operating activities Cash flows from investing activities Cash flows from financing activities www.A. 7 I.S. An example would be cash in the bank less any overdraft.A. It gives us a detailed proforma and certain definitions: Cash Cash that is available on demand.
Proforma Statement of Cash Flow for year to ……. $ Cash flows from operating activities Profit before tax Adjustments for: Interest payable Depreciation (Profit) / loss on the disposal of a non current asset Operating profit before working capital changes Working capital changes (Increase) / Decrease in inventories (Increase) / Decrease in receivables Increase / (Decrease) in payables Cash generated from operations Interest paid Taxation paid NET CASH FROM OPERATING ACTIVITIES (X) X (X) X X (X) X (X) (X) X X X (X) X X X $
Proforma continued $ NET CASH FROM OPERATING ACTIVITIES Cash flow from investing activities Purchase of a non-current asset Disposal of a non-current asset Interest received Dividends received CASH FLOW FROM INVESTING ACTIVITIES Cash flow from financing activities Proceeds from the issue of shares Receipt of loans Repayment of loans Dividends paid CASH FLOW FROM FINANCING ACTIVITIES NET CASH FLOW Cash and cash equivalents at the beginning of the period X Cash and cash equivalents at the end of the period X X X (X) (X) X X (X) X X X X $ X
Example 1 Radiance Limited Statement of Financial Position As at 31 December 2007 2006 Non-current assets Cost Accumulated depreciation Current assets Inventory Trade receivables Bonds Cash Capital and reserves Share capital Share premium Accumulated profits Non-current liabilities Loan Current liabilities Payables Tax 19 1 129 13 3 181 30 20 45 10 24 65 12 68 12 2 10 3 129 17 10 10 16 181 180 (78) 102 220 (92) 128 2007
Notes The tax charge in the statement of comprehensive income is $6,000. Loan was repaid at the end of the financial year. Required Prepare the cash flow statement for the year ended 31st December 2007.
studyinteractive.Solution $ Cash flows from operating activities Profit before tax (68 – 24) + 6 Adjustments for: Interest payable Depreciation (92 – 78) (Profit) / loss on the disposal of a non current asset Operating profit before working capital changes Working capital changes (Increase) in inventory (17 – 12) (Increase) in receivables (10 – 2) (Decrease) in payables (19 – 13) Cash generated from operations Interest paid Taxation paid (working 1) NET CASH FROM OPERATING ACTIVITIES (5) (8) (6) 45 (4) 41 14 64 50 $ www.org 85 .
$ NET CASH FROM OPERATING ACTIVITIES Cash flow from investing activities Purchase of a non-current asset (220 – 180) Disposal of a non-current assets Interest received Dividends received NET CASH USED IN INVESTING ACTIVITIES Cash flow from financing activities Proceeds from the issue of shares (65 – 45) + (12 – 10) Receipt of loans Repayment of loans Dividends paid CASH FLOW FROM FINANCING ACTIVITIES NET CASH FLOW Cash and cash equivalents at the beginning of the period (10+3) 22 (10) (40) - $ 41 (40) 12 13 13 Cash and cash equivalents at the end of the period (10+3) 26 www.org 86 .studyinteractive.
000 33.studyinteractive.Working 1 Taxation Liability 01/01/07 Cash paid (Bal Fig) 31/12/07 c/d 4 3 7 01/01/08 b/d 7 7 31/12/07 b/d Charge for year 1 6 Direct Method The direct method involves adding together the cash inflows and deducting the cash outflows.000 12.org 87 .000 11.000 44.000 20. Example 2 The following information relates to Empress Limited: Cash sales Cash received from customers Cash purchases Cash paid to suppliers Cash expenses Cash wages and salaries 55.000 Required: Calculate the cash generation for Empress Limited www.
Solution Cash sales Cash received from customers Total cash received 55.000 44.000 23.000 76.studyinteractive.org 88 .000 20.000 Cash purchases Cash paid to suppliers Cash expenses Cash wages and salaries Total cash paid Cash generated 33.000 12.000 99.000 www.000 11.
Example 1 A sole trader’s statement of financial position at 31st December 2006 shows that the business has net assets of $5. Calculating profit If a business has very little information about its transactions.000.studyinteractive. incomplete records are any form of accounting records other than the full double entry system. it may only be possible to calculate its net profit for the year. This is because their clients are not likely to fully understand the double en try system. The accounting equation can be written as: Net Assets = Capital + Profit . The main reason is often due to a flood or fire at the business premises. This can be done by using the accounting equation (this is very important).500 and he didn’t introduce any further capital in the year Required Calculate the profit for the year ended 31st December 2007. www.SESSION 12 INCOMPLETE RECORDS Introduction As the name suggests.000. The statement of financial position at 31st December 2007 shows that the business has net assets of $8. The owner’s drawings for the year amounted to $2.org 89 . students will often come across incomplete records. need to prepare a set of financial statements for the client. During the exam. accountants come across incomplete records almost daily. We still however. In reality.Drawings Or Change in net assets = Capital introduced + Profit – Drawings You may realise that this is very similar to the statement of financial position.
Ratios for mark-up (based on cost) or margin (based on selling price) Balancing figures The balancing figure approach is commonly used the following way: Ledger Account Accounts receivable Missing Figure • • Accounts payable Cash at bank Cash in hand Example 2 • • • • • • Sales Money received from accounts receivable Purchases Money paid to accounts payable Drawings Money stolen Cash sales Cash stolen www.000 Profit = 0 5. In these types of questions you will be given information regarding the opening and closing balances of assets and liabilities of the business. Preparing financial statements from incomplete records In the majority of cases a small business will keep limited amount of records.Solution: Change in net assets 3. You will also be given information about certain transactions during the period. this is usually a summary of the cash book.500 = Profit As you can see it is impossible to know the make-up of the net profit figure due to lack of information.500 This can be written as: 3. Balancing figures in ledger accounts 2.org 90 . There are two main techniques used in incomplete records: 1.000 = Capital introduced 0 + Profit for the year ? Drawing in period 2.studyinteractive.500 + 2.
000 55.000 and the closing balance was $55.000 of which $15. We can calculate credit sales as above and then add on cash sales. irrecoverable debts have been written off worth $5.000 and the closing balance was $37.000 30. Required: What were the credit sales for the year? Account Receivables Opening b/d Sales (Bal Fig) 50.000 Example 3 Suppose that the opening accounts receivables balance was $30.000 31/12/07 31/12/07 Total receipts Discounts allowed 55.Separate sales Account Receivables www. or we can use the ledger account to calculate total sales.studyinteractive.000 45.000 95.Total sales Account Receivables (Total Sales a/c) 01/01/07 31/12/07 b/d Total sales (Bal fig) 65. Discounts allowed in the year totalled $3.Suppose that the opening balance on the accounts receivables ledger was $50.000 relates to receipts from accounts receivables. Required: What are the total sales for the year? Due to the information given in the question we can approach this in 2 different ways.000.000.000 3.000.000 55.000 Solution 2 . Both methods are shown below: Solution 1 .000 105.000 c/d 37.000.000 31/12/07 95.000.000 5. there have been total receipts from customers of $55. there had been receipts from account receivables in the year of $45.000 Receipts Bad debts Closing c/d 105.000 relates to cash sales and $40.org 91 .
000 63.000 and the closing balance was $26.000 www.000 Example 4 The opening balance on the accounts payable ledger was $30. discounts received are $4.000 Credit sales Cash sales Total sales 50.000 4.000 26.000 3.000. Payments made to account payables during the year were $33.000 31/12/07 Purchases 33.studyinteractive.000 37.000.000 65.000 31/12/07 31/12/07 31/12/07 Credit receipts Discounts allowed c/d 40.000 63.01/01/07 31/12/07 b/d Credit sales 30.000 80.org 92 . Required: What was the total purchases figure for the year? Solution: Payables Control a/c 31/12/07 31/12/07 31/12/07 Payments Discounts received c/d 33.000 50.000 15.000 01/12/07 b/d 30.000.000 80.
100 350 450 Solution: Rent and Rates 01/01/07 31/12/07 31/12/07 Rent b/d (Prepaid) Cash paid Rates accrued 300 4.000.500 25.studyinteractive. the total payments made to suppliers was $14.000 25.000 related to credit purchases.500 31/12/07 Purchases 10. Opening balance Cash paid during the year Closing balance Rent prepaid Rates accrued Rent and rates Rent prepaid Rates accrued 300 500 4.000 Example 6 The following information relates to the rent and rates for Susan for the year ended 31st December 2007.000 500 11. Required: What was the total purchases figure for the year? Solution: Total Purchases a/c (Account Payables) 31/12/07 31/12/07 31/12/07 Total payments Discounts received c/d 14.000 350 4.100 450 4.500 01/12/07 b/d 15.Example 5 Suppose the opening accounts payable balance is $15.850 www.850 01/01/07 31/12/07 31/12/07 Rates b/d (Accrued) Charge (Bal Fig) Rent prepaid 500 4.000.org 93 . Discounts received were $500 and the closing balance was 11.000 of which $10.
000 2.227.367.227 12.367 8. Required: How much cash was received from customers during the year? Solution: Cash Account 01/01/07 31/12/07 b/d Receipts 900 13. During the year cash of $10.000 www.000 14. payments in the year totalled $8.000 Banked Drawings Wages c/d 10.130 Example 8 Scott has a cash float at the beginning of the year of $900.studyinteractive. $1.000 was banked.130 b/d Payments c/d 1.536 2.org 94 .000 at the end of the year. Scott decided to increase the float to $1. Required: What is the total receipts figure for the year? Solution: Cash Book 31/12/07 Receipts 12.Example 7 On 1st January the bank is overdrawn by $1.000 was paid out for drawings and wages of $2.000 1.100 31/12/07 31/12/07 31/12/07 31/12/07 14.130 01/01/07 31/12/07 31/12/07 12.000 1.000 was paid.536 and on 31st December the closing balance was a positive balance of $2.
000 x 100 = 20% Example 9 Margin Required: What is the gross profit and cost of sales? $ Sales Cost of sales (1.studyinteractive.000 4.000 / 5. This percentage can be calculated based on the sales figure or the cost of sales figure.000 1.000 750 250 % 100% 75% 25% 25% Sales $1.org 95 .000 Gross profit mark-up Gross profit margin 1.000 www.000 / 100 x 75) (Bal fig) Gross profit 1.000 x 100 = 25% 1.Ratios – Mark-up and Margin The gross profit of a company can be expressed as a percentage. • • Gross Profit Mark-up Gross Profit Margin Based on Cost of Sales Based on Sales If we look at the following trading account: Sales REvenue Cost of sales Gross profit 5.000 / 4.
Example 10 Mark-up Required: What is gross profit and sales? Sales (600 / 100 x 125) Cost of sales Gross profit 750 600 150 125% 100% 25% 25% Cost of sales $600 Example 11 Mark-up Sales Opening inventory Closing inventory Required: Complete a trading account from the above information.org 96 .000 Gross profit (6.200 (500) 6.600 $300 $500 www. Sales Cost of sales Opening inventory Purchases (Balancing Figure) Closing inventory 300 6.600 110% 10% $6.studyinteractive.600 / 110 x 10) 600 100% 10% 6.
Example 12 Margin Purchases Opening inventory Closing inventory Required: Complete a trading account from the above information. to work out the cost of lost inventory.840 (600) 3. www. Sales (3. Lost inventory has also not been sold in the year and therefore also needs subtracting within cost of sales.840 $800 $600 Cost of lost inventory In incomplete record questions.studyinteractive. it is likely that inventory has been lost due to the infamous fire or flood. Closing inventory that has not been lost is subtracted in cost of sales because by definition.org 97 . Therefore.200 100% 5% $2.040 / 95 x 100) Cost of sales Opening inventory Purchases Closing inventory 800 2. the inventory has not been sold in the year.040 Gross profit 160 95% 5% 3. complete the trading account from the information given and then lost inventory can be calculated as a balancing figure.
000 $10.000 80% 20% 100. Sales Cost of sales Opening inventory Purchases Closing inventory Inventory lost in fire (balancing figure) 10.000 100% 20% $100.000 $82.000 Gross profit (100.studyinteractive.000 www.000) 80.Example 13 Margin Sales Opening inventory Closing inventory (after fire) Purchases Required: Complete a trading account from the above information.000 $3.000 82.org 98 .000 / 100 x 20) 20.000) (9.000 (3.
Howard.000 into the partnership. He withdrew $30. A partnership will usually have a “Partnership Agreement” which will state how the profits are to be shared amongst other things. This makes it necessary to share the profits of the business amongst the partners.org 99 . Gary invested $50.000 on 1st January 2007. Consequently he withdrew $25.000 from the business on 1st July 2006.studyinteractive.000 into the partnership. the profits of the business are owned by the partners. Howard is poor but clever and could only invest $20. In the same way as for a sole trader. Jason is rich but stupid. In the year to 30th June 2007 the partnership has made profits totalling $106.000 on 1st July 2006 and a further $25.000 and withdrew $30.000 on 30th June 2007. He has a liking for designer clothes and fast cars. Due to him being clever and completing work quicker than the other partners he took responsibility for hiring and firing staff in the business.000 into the partnership. He withdrew $30.000 on 1st July 2006.SESSION 13 PARTNERSHIPS Definition “The relationship which subsists between persons carrying on a business in common with a view to profit” A partnership therefore has two or more partners or owners. He was made a partner because he could invest $100. The partners have decided that profits should be distributed at a ratio of 2 : 1 : 3 : 4 (Jason : Howard : Gary : Mark) How do you think the profits should be shared amongst the partners? www. THE SHARING STORY A partnership has four partners – Jason. Mark’s wife has just had a baby and he would therefore like to have a guaranteed share of the profits. Mark also invested $50. Gary and Mark.250.
salaries and interest on drawings.studyinteractive. Profit sharing ratio This is the ratio in which any remaining profits should be shared amongst the partners after they have been allocated interest on capital. Salaries To reward those partners who take on extra responsibilities with-in the business. but a way in which profits are allocated. the shortfall should be given to the partner.Interest on capital To reward partners who have invested more into the business. allocate the profits of the business in accordance with the following partnership agreement: a) Interest on capital is 5% per annum b) Howard is to receive a salary of $5. Interest on drawings results in a reduction in the amount of profit the partner is allocated.000 c) Interest on drawings is 10% per annum d) Profit sharing ratio is as stated 2 : 1 : 3 : 4 e) Mark has a guaranteed minimum profit share of $42. This is called interest on capital. A partners’ salary is not a business expense like the salary of an employee. If the partner has not received this share after allocating profits in accordance to the above. Guaranteed minimum profit share A partner may be guaranteed a minimum share of the profits.org 100 . Interest on drawings To penalise those partners who take out more drawings from the business. the partnership may charge interest on drawings. the partnership may allocate some of the profits based on the level of capital invested. Example 1 Using the amounts detailed in the sharing story.500 www. The short fall is then taken from the other partners in accordance with the profit sharing ratio. they may receive a salary.
2 : 1 : 3 : 4 Guaranteed share 5. The capital account will have a credit balance.000) 21.000 (1.000) (5.250 2.org 101 .000 42.S.750 100.500 Howard Gary Mark Total 106.000 10.000) - Financial statements for a partnership The format of the financial statements for a partnership will be the same as for a sole trader except for the capital section of the statement of financial position.500 (3.000 16.000) 20. The account will remain fixed unless more assets are introduced. Each partner will have a capital account and a current account. Capital Accounts A B C Balance b/d Bank Balance c/d X X X X X X X X X A X X B X X C X X www.000 5.Appropriation of Profit Account Jason Profit Interest on capital Salaries Interest on drawings P. Capital account This will record the assets that have been introduced into the partnership.500 (3.studyinteractive.000 (100.500) 27.R.250 (11.500 2.750) 30.500 3.000) 40.000 39.000) 9.000 1.000 (3.750 (1.000 22.000 (500) 15.000 28.
Current Accounts A B C Balance b/d Share of profits Drawings Balance c/d X X X X X X X X X X X X Loan interest A X X X B X X X C X X X The capital section of the statement of financial position will look like: Capital Accounts A B C Current Accounts A B C X X X X X X X X www.studyinteractive.Current account The current account will record the partners’ share of profits and drawings. The current account will usually have a credit balance but may have a debit balance indicating that they have withdrawn more than the profits they are entitled to.org 102 .
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